When it comes down to it success in managing personal finances is pretty simple: Spend less than you earn over a long period of time and invest the difference.<\/p>\n
Said another way, they boil down to E-S-I. If this is the heart of your financial plan, it\u2019s likely that you\u2019ll be prosperous.<\/p>\n
That said, there is one other thing you\u2019ll need to do \u2014\u00a0you must avoid the financial pitfalls that can significantly derail your finances. I call these the worst money moves anyone can make.<\/p>\n
I\u2019m listing them below in countdown fashion along with some suggestions for avoiding them.<\/p>\n
Here are the top ten:<\/p>\n
An emergency fund is your first line of defense against unexpected financial problems.<\/p>\n
And believe me, unexpected financial problems happen rather regularly. Washing machines break, cars need repairs, kids need braces, and so on. It\u2019s a fact of life.<\/p>\n
If you don\u2019t have an emergency fund, you will likely have to borrow money when an emergency pops up. And as we\u2019ll see soon, borrowing is an even worse money mistake.<\/p>\n
So how much should you save in your emergency fund? A good rule-of-thumb is to have six months\u2019 of living expenses saved up. In addition, be sure to keep your emergency fund in a safe place \u2014 you certainly want it to be there when you need it. Don\u2019t worry about earning a ton on it, no one ever became rich by making money off their emergency fund, just make sure it\u2019s safe and accessible.<\/p>\n<\/div>\n
Money magazine reports that 57% of Americans don\u2019t have a will, including 69% of parents with kids under 18.<\/p>\n
Without a will, guess who decides what happens with your finances and your kids? The state! Do you really want to let your state decide these issues for you?<\/p>\n
To avoid this bad money move, you need a will and the other documents that account for good estate planning \u2013 probably at least Patient Advocate and Medical Records Release documents for most people. And be sure to update them regularly as your life situation changes.<\/p>\n
I think of insurance as a very big emergency fund that supplements your cash emergency fund. It covers the things you couldn\u2019t save up to cover in advance, helping to replace\/protect the largest assets you have \u2013 your career, your home, your investments \u2013 if you experience a major accident, death, or injury.<\/p>\n
I\u2019d suggest you have adequate coverage in the following insurance categories:<\/p>\n
\u2022 Auto<\/p>\n
\u2022 Homeowner or Renter\u2019s<\/p>\n
\u2022 Life<\/p>\n
\u2022 Long-term Disability<\/p>\n
\u2022 Health<\/p>\n
\u2022 Umbrella<\/p>\n
\u2022 Long-Term Care (this one isn\u2019t mandatory yet IMO, but I\u2019m still considering it)<\/p>\n
One more bit of advice: Do not go overboard and become over-insured. No one needs to win the lottery when misfortune occurs (for example, your family most likely does not need a $10 million life insurance policy on you. If you have one and you don\u2019t make $1 million a year or so, you\u2019re probably spending too much on life insurance.) But you do want to be sure you have enough insurance to replace your assets in times of trouble or loss. Take a balanced view and only pay for what you truly need.<\/p>\n<\/div>\n
There are actually two major financial mistakes related to marriage: marrying a spendthrift and getting divorced.<\/p>\n
Couples where both spouses know and apply financial basics do much better than ones where one or both spouses have bad financial habits. The Millionaire Next Door says:<\/p>\n
“What if your household generates even a moderately high income and both you and your spouse are frugal? You have the foundation for becoming wealthy and maintaining your wealth. On the other hand, it is very difficult for a married couple to accumulate wealth if one is a spendthrift. A household divided in its financial orientation is unlikely to accumulate significant wealth.”<\/p>\n
In addition, a divorce is a major hit to any couple\u2019s finances. According to the Journal of Sociology, those who divorced saw their wealth shrink by 77 percent \u2013 a larger decline than would occur by simply splitting a couple\u2019s assets in half.<\/p>\n
My advice is to discuss finances prior to marriage to make sure you\u2019re financially compatible. Once married, stay married. And make financial decisions as a couple.<\/p>\n
As I noted earlier, the formula for financial prosperity is pretty simple:<\/p>\n
\u2022 Spend less than you earn<\/p>\n
\u2022 Do this for a long time<\/p>\n
If you do these two things, you will be wealthy. Why? Because you\u2019re saving money.<\/p>\n
On the other hand, if you\u2019re not saving, you\u2019re not making progress financially. And the longer you wait to save, the harder it will be to catch up later.<\/p>\n
The proper financial move is to save a portion of every paycheck you receive. A good rule-of-thumb is to start out by saving at least 10% of your income, and from there the amount should increase over time.<\/p>\n
And some may ask just what you are saving for? Any major expense you know you\u2019ll have in the future: a house, retirement, cars, college costs for kids, etc.<\/p>\n<\/div>\n
I\u2019ve talked a bit about how to buy a house and there\u2019s really not much else to say other than this guideline from the book “Stop Acting Rich: \u2026And Start Living Like A Real Millionaire”:<\/p>\n
If you\u2019re not yet wealthy but want to be someday, never purchase a home that requires a mortgage that is more than twice your household\u2019s annual realized income.<\/p>\n<\/div>\n
There are three factors that determine how well your investments (savings) perform:<\/p>\n
\u2022 The amount that\u2019s invested (how much is invested)<\/p>\n
\u2022 The return rate on your investments<\/p>\n
\u2022 The length of time they are invested<\/p>\n
Most of what we see in the press deals with getting the best return on your money. But actually, the factor that most influences the value of your investments is the time you have it invested.<\/p>\n
And the longer you wait to save and invest, the more you\u2019re costing yourself.<\/p>\n
Here\u2019s an example that illustrates the power of saving early:<\/p>\n
Smart Saver starts saving $3,000 every year, starting at age 20. After 10 years, her $30,000 total contributions are worth $47,000 (at an annual growth rate of 8%). At age 30, Smart Saver stops saving and makes no further contributions. She just lets the money grow at an 8% annual rate of return for the next 30 years, until age 60. At age 60, the $47,000 will have grown to $472,000.<\/p>\n
Her sister, Late Saver, waits until age 30 before she starts saving $3,000 a year. Unlike her Smart Saver sister who stopped saving after 10 years, she doesn\u2019t stop saving. She saves every year for 30 years, from ages 30 until she is 60. At age 60, her account is worth only $367,000.<\/p>\n
Now I\u2019ll add a couple extra points to this example to show how Smart Saver could really have made it big in saving and investing for retirement:<\/p>\n
\u2022 If Smart Saver would have kept saving $3,000 her whole life, she would have ended with almost $835,000.<\/p>\n
\u2022 And if that $3,000 would have been $5,000, she would have ended with $1.4 million.<\/p>\n
So the solution for this money problem is to:<\/p>\n
\u2022 Save early<\/p>\n
\u2022 Save often<\/p>\n
\u2022 Save more (as a percentage of your income) as time goes by<\/p>\n<\/div>\n
AARP notes that, \u201cOver a lifetime, the average American will now pay over $600,000 in interest.\u201d<\/p>\n
$600k? Ouch! This is a pretty big example of the fact that debt is very costly \u2014 it can rob you of hundreds of thousands of dollars.<\/p>\n
The solution to this mistake is simple:<\/p>\n
\u2022 If you\u2019re in debt, start taking my steps for how to get out of debt.<\/p>\n
\u2022 If you\u2019re not in debt, don\u2019t get into debt.<\/p>\n<\/div>\n
Your career is your most important financial asset.<\/p>\n
This is because the average American can reasonably expect to earn in the neighborhood of $2 million during his lifetime. But if that person works hard and grows his income at 8% per year, he could have more than $3 million more than that. If he doesn\u2019t, his $2 million can dry up to a bit over $1 million (or even less). So not working to make the most of your income can cost you millions of dollars.<\/p>\n
To avoid this bad money mistake, simply develop and execute a plan to make the most of your career.<\/p>\n
And let me add a couple other mistakes you do not want to make because they can derail your career and your income as well:<\/p>\n
\u2022 Do not quit your job without another job lined up. Yes, it may be stressful to work where you do, but not having enough to eat is much more stressful.<\/p>\n
\u2022 You must take care of yourself physically. Eat well, get plenty of rest, exercise, and enjoy life. Your career and its earning potential are dependent on you being able to work.<\/p>\n<\/div>\n
If your outflow exceeds your income, then your upkeep will be your downfall.<\/p>\n
The first step to gaining wealth is spending less than you earn \u2014 it\u2019s vital to making any financial progress. So when you over-spend, you\u2019re doing the most damage possible to your finances.<\/p>\n
Here\u2019s what “Stop Acting Rich” says about the issue:<\/p>\n
“Most people will never earn $10 million in their lifetime, let alone in any single year. In fact, most households (97%) are unlikely to ever earn even $200,000 or more annually. So what if you are unlikely to become rich by generating an extraordinarily high realized income? The only way you will become rich is by being like those millionaires at the other end of the continuum: by living well below your means, by planning, saving, and investing.”<\/p>\n
There are two types of over-spending that can ruin your finances:<\/p>\n
\u2022 Over-spending on the little things \u2013 the small amounts that seep out of your pockets here and there and eventually become large.<\/p>\n
\u2022 Over-spending on the big things \u2013 homes, cars, boats, cottages, and so on.<\/p>\n
The top complaint I hear from people who don\u2019t have balanced budgets is, \u201cI don\u2019t make enough money.\u201d<\/p>\n
I\u2019m telling you that in the vast majority of cases (probably 95% or more), it\u2019s not the amount these people make \u2013 but the amount that they spend that\u2019s the problem. (In some cases it\u2019s true that people simply don\u2019t make enough money to save, invest, etc. As such, they need to concentrate on increasing their income as much as they need to control over-spending.)<\/p>\n
My wife and I once counseled a guy who made $130,000 a year. This was back in the early \u201890\u2019s, so $130,000 was worth something (it\u2019s still pretty good today.) When I saw his income, I thought \u201cthis will be a piece of cake\u201d to make a balanced budget. But once we got through the mortgage on the mansion he owned, the four luxury cars he leased for himself, his wife, and his kids, and the amounts they spent on clothes and vacations \u2013 they had spent it all and then some.<\/p>\n
This is why over-spending is the #1 money mistake \u2013 because no matter what your income is, if you spend it all plus some, you\u2019re going backwards financially and you\u2019re losing ground.<\/p>\n
<\/p>\n
–<\/p>\n